Canadian portfolio manager Stephen Jarislowsky, wrote in 2005 that investors more often than not, can buy IPO stocks for less than their issue price within 12-24 months of going public. Levi Strauss (NYSE:LEVI) went public in March 2019 at $17 a share. A little more than 18 months since its IPO, LEVI stock is trading for less.
No truer words have ever been spoken than those of the iconic investor. Levi’s stock gained 31.8% on its first day of trading. That’s not an uncommon occurrence for IPO stocks. Since then, it’s been mostly downhill.
Now, with Levi’s ready to announce earnings after the markets close on Oct. 6, those interested in getting a deal on LEVI stock are likely asking themselves whether they should be buying before or after the results are in.
Here are my thoughts on both sides of the argument.
Buy LEVI Stock Before Earnings
Over the past four quarters, Levi’s has beaten analyst estimates by an average of three cents a quarter. In four consecutive quarters, from Q3 2019 to Q2 2020, it’s beaten the consensus estimate.
And while the last beat was by a penny on an adjusted loss of 48 cents versus the 49-cent estimate, LEVI stock lost ground on the July news. Since then, we’ve heard very little from the company.
However, it did say in its second-quarter press release that it had $2 billion in liquidity to survive whatever bad news on the sales front the novel coronavirus brings; $1.4 billion of that in cash.
Further, while the company’s withdrawn all guidance for investors, it did say in July that 90% of its company-operated and franchisee stores have reopened globally, including most of its third-party retail locations. As a result, you can expect the third-quarter results will be much improved sequentially over the second-quarter results.
A Deeper Analysis on Quarterly Performance
“While traffic and sales remain down to prior year, weekly sales performance in company-operated doors is sequentially improving, as store sales productivity in the final week of June as compared to prior year approached 80 percent, with nearly 40 percent of open company-operated store locations delivering positive net revenues growth compared to the same week in the prior year,” the company stated in its Q2 2020 press release.
“As store locations have reopened, the company’s e-commerce net revenues growth has remained strong, at nearly 70 percent growth for the month of June as compared to the same month in the prior year. Cash flow trends are also improving, as net cash flows from operations were positive in June.”
According to analyst estimates, Levi’s should deliver a 22-cent loss in the third quarter, a drastic improvement from the second quarter–but still a loss.
In late July, my InvestorPlace colleague, Luke Lango, gave three reasons why LEVI stock was undervalued at $12 a share. One of Luke’s arguments was that a second stimulus check would goose consumer spending. When the last check went out, 20% of Americans spent their stimulus check on clothing.
What could be more essential in this day and age than a new pair of jeans?
I know anecdotally here in Canada that many people bought new sofas with the Canadian government’s version of the stimulus check. Jeans are a much cheaper purchase and an expense that’s far easier to justify.
So, it’s possible that Levi could surprise investors with a big beat to the upside when it reports Oct. 6.
Wait Until After the Results Are In
I was never a fan of Levi’s IPO. Before it went public in March 2019, I wrote about the 7 Reasons to Steer Clear of Levi IPO. One of those reasons was I believed its IPO valuation was too expensive at 8.2 times adjusted EBITDA. Based on the twelve-month period ended May 24, 2020, it is valued at 39.5 times its adjusted EBITDA.
Now, we know Levi’s will return to profitability at some point, but if you think its stock is cheap at current prices, I’d say you’re far too easy on the company.
The other big issue I had with Levi’s was the amount of debt on its balance sheet. At the time of its IPO, it had $1.1 billion in debt, with $713.1 million in cash for net debt of $339.0 million. That’s relatively healthy. However, if you add in capital leases, it would have been a lot higher.
How Much Higher?
Well, in the second quarter, it had $1.5 billion in long-term debt, $307.9 million in short-term debt, and $839.6 million in long-term lease liabilities. Subtract out cash of $1.44 billion, and its net debt was $1.2 billion, almost four times what it was 18 months ago.
Jumping back to valuation, Levi’s had free cash flow of $120 million in the trailing 12 months, down from $240 million at the end of fiscal 2019. Based on a current enterprise value of $6.87 billion, it has an FCF yield of 1.7%.
I don’t know about you, but I don’t consider that enough of a margin of safety given the second wave of Covid-19 is on the rise in America. Shops could close once more.
Bottom Line on Levi Stock
Of all the top retail names out there, LEVI stock is not the one I’d be buying at this point. However, if you feel it’s worth owning, I’d at least wait until after earnings to do so. More information is better in this situation.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.